401k Lump Sum Contribution: Dollar Cost Averaging Looking Good Right Now

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I’ve been really bad at regularly making contributions to my Self-Employed 401k from Fidelity. I had only planned to put $500 a month into it for the first part of the year, since I wanted to keep as much liquid cash as possible in case I bought a house. Now that it seems like (1) we’ll have enough money both buy a house and contribute to the 401k, (2) we’ve may not buy right away anyhow since we can’t agree on what we want, and (3) the year is quickly coming to an end, I went ahead and sent in a lump sum of $10,000 to catch up!

My problem: The money just showed up on my account today, so I will have to wait until Monday to trade. This is the same day Mr. Bernanke plans on making his Fed Funds rate announcement, which will either calm the market down (drop 0.25%), make it really unhappy (keep it the same), or make it really happy (drop 0.5%). Even with the subprime mess, I am definitely still going invest my money into the stock market… but should I do it all at once?

Usually, in the arena of dollar cost average vs. lump sum my position has been:

If you already have all the money available (not if you’re just taking a set amount out of each paycheck) and you are well away from retirement, you should just invest the lump sum all at once.

This is supported by several studies, including this FPA Journal article Lump Sum Beats Dollar-Cost Averaging, which concludes:

Given a lump sum, is it better to invest the entire amount immediately, or spread it out in equal installments? Based on historical evidence, the major conclusion of our study is that the odds strongly favor investing the lump sum immediately. This conclusion emerges after comparing annualized monthly returns for both DCA and LS strategies for all possible 12-month periods from 1926 to 1991. For the entire 65-year period, the LS strategy produced superior returns approximately two-thirds of the time, and the superior returns were statistically significant.

So it turns out 2/3rds of the time you win out, and 1/3rd of the time you lose. Not bad. The next argument that some people make is DCA is more of a risk-reduction method than anything else. Again, multiple academic articles suggest that DCA may not be a very efficient way to reduce risk, either! Bummer.

Still, given the Bernanke situation, I am considering dollar-cost-averaging $1000 a day over the next two weeks instead of $10,000 all at once on Monday. Prudent idea, or backtracking?

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  1. Toss up. 2 weeks is essentially a lump sum. As I recall from the studies you refer to, one of the big things in favor of the lump sum was getting the earlier dividends. You pass up a lot of dividends by investing over a period of a year. That’s not so true over 2 weeks.

    Personally, I’d be inclined to spread a large sum out a bit also. It isn’t likely to make much difference, and you’ll feel happier, so where’s the negative?

    And the truth is, dollar cost averaging doesn’t just get you in at the average price, it gets you in at the harmonic mean price. Most people don’t know the difference between means, but harmonic

  2. I was under the impression that DCA usually took place over a longer period of time than just 10 (or 14) days? I would think that, over several years, doing it that rapidly will be effectively the same as a LS contribution unless the market _really_ moves. I guess it’ll smooth the short term fluctuations though, which could be interesting over the next two weeks 🙂 If you choose to go DCA (or even LS perhaps), you should record some numbers to make some cool graphs once it’s complete to add to the data for each style.

  3. Well, I put a bunch of money into my Roth IRA in mid July…then had the same debate. I chose DCA and it turned out my first stock buys hit the exact peak of the market. I’ve since contributed more on dips and made up for the unfortunate first buy. As the first comment noted, you really want to wait longer for proper DCA (e.g., until more info on the possible recession becomes available). For example, split it into 4 quarterly blocks over a year.

    Note the “Sell in May and go away” phenomenon too. Some also include the effect of the particular season/month on the DCA/lump sum debate. Summer is notoriously unpredictable and bad.

    As my Roth IRA is also meant as a flippy fund (either pull some cash out for housing or save it all for retirement) I’m pretty conservative. I plan to continue with DCA. Also, if you’ve got a significant bond ratio in your portfolio you may reduce short term risk by buying both stocks and bonds at the same time.

    In the end it comes down to your investment horizon…if you won’t touch the money for 10+ years it won’t matter what you do so get it in early…if the money may be needed in 5 or fewer years use DCA.

  4. Minor correction but I think the Fed meets and decides on interest rate on Tuesday, 9-18-07?

  5. I agree with Christopher. When I consider DCA, I’m looking at a once a month strategy, rather than once a day. I also break my rule based on cost, so that if an investment drops to a pre-determined level prior to the month end, I’ll purchase my next ‘installment’.

    Rather than using DCA into your 401k, you might also consider adjusting your investments based on your perceived risk of the market. Fidelity has plenty of good funds to move money into if you think that the stock market has some room to drop.

  6. I’m generally a fan of dollar cost averaging as a way of taking the decision out of your hands. It is what it is. When you invest lump sum even when your default decision is to invest as soon as you get it – that’s a very big decision. But then again, I’m also a more active investor who actually does try to market time and pick stocks on a limited basis…

  7. Regardless of all the research, part of your decision should be what you are most comfortable with. I try to remove emotions from my investing as much as possible, but if you are more comfortable DCA’ing the money then go for it.

  8. You should do whatever lets you sleep at night. However, I don’t think DCA’ing over such a short time period makes much of a material difference in the long-run. Some have suggested that if going lump sum into your portfolio makes you hesitate, then you may need to re-evaluate your equity % and the amount of risk you are willing to take.

    It’s also been historically shown that the majority of big returns on your portfolio occur on only a handful of days. I’d personally rather be in the market than out of it because, frankly, no one can reliably predict the future and when one of those big days is about to happen.

    BTW, you should check out the diehards.org forums. There have been a lot of recent discussions on the lump sum v. DCA debate, given all the recent market volatility.

  9. Do you have commission fees for each transaction? If so, then I would consider doing fewer transactions.

    My thoughts on DCA: You can do it over whatever time period you want. I maxed out my Roth IRA in January this year, but that is still dollar cost averaging if I do it every year at the same time – it is just over a longer time period. Some people prefer to invest with bi-monthly paychecks (example – 401k), and others invest monthly, quarterly, or annually. It can all be considered DCA. (at least in my opinion).

  10. I agree that DCA over such a short period of ten days is essentially a lump sum contribution.

    With stocks being reasonably priced by historical standards, I wouldn’t worry too much about making a lump sum contribution. If this was 2000 it might be a different story.

  11. That’s a lot of stocks you have there. Shouldn’t you put some of your money somewhere else? And btw, how did you make your mymoneyblog.com site? Do you pay for the domain or did you get a free one?

  12. It won’t make any significant difference a year from now.

    The typical rational for DCA is that you are afraid of risk. But that implies that your stock allocation is too high. So really you should drop it until you are comfortable with contributing as a lump sum.

  13. “Even with the subprime mess, I am definitely still going invest my money into the stock market? but should I do it all at once?”

    When you say “stock market” here I hope you’re not just talking about the US stock market. Consider this: if you put the same amount of money into a DOW index fund back in 2001 and also into the Canadian Dollar the Canadian dollar investment would be ahead of the DOW investment by a bit more than 10% right now (The Canadian dollar is now worth more than the US dollar). So currencies might be one place to park some cash as the outlook for the US Dollar doesn’t look very good (and a lot of that is connected with the subprime mess). You might also want to consider some ETFs that short various market sectors like SKF (Ultrashort financials) and SRS (ultrashort real estate) – you wouldn’t want to park money there for a very long term of course, but over the next six months or so these could be a very good place to be as we see more fallout from the subprime implosion… It’s sort of like having your own hedge fund.

  14. Trying to time the market is really hard to resist, isn’t it? But in this case, I think it would be prudent to wait till Tuesday. Hasn’t the market already priced in a rate cut? In which case, why not wait just in case Bernanke surprises everyone and doesn’t cut?

  15. The Canadian dollar is not more than the US dollar.

    Right now, 1 CAD = 0.970356 USD.

    Investing in currency is stupid because your expected return is 0%.

  16. Doh, I thought they met on Monday. I’ve been off on dates all week.

    I also agree that in 40 years this won’t hardly make any difference. I would just seem silly to invest on a day with there is likely to be a big market overreaction in one direction or another. Maybe I’ll will just invest it all beforehand on Monday.

  17. Ted Valentine says

    The Fed’s rate cut is already priced in the market.

  18. Well, an expected .25% rate cut is priced-in according to the futures, but if that’s not what actually happens, then the market will react (or overreact) accordingly.

    I think I’ve just been watching the market too much, with it going up or down 1-3% every day based on every little news announcement. Thanks for the comments and helping me think through this. I’m going to put in my buy order tonight for Monday and just leave it at that. I like to keep things simple in this regard.

    No commission fees for me, I’m just buying Fidelity index funds inside a Fidelity account.

  19. The lump some contribution is something I’ve been thinking about for a while with my roth. I decided a few months ago that I would contribute the max next year all at once. I think the historical data is pretty compelling.

  20. “The Canadian dollar is not more than the US dollar.
    Right now, 1 CAD = 0.970356 USD.”

    Ah, sorry, that was news from the future…

    But you still would have done very well with Canadian $$ over the past 7 years.

  21. How are you able to make a lump sum contribution to your 401K? My contributions are taken from my paycheck. I don’t have the option to send in a check from my personal finances. Even if I set my contribution rate at 100% of my paycheck it would be a several paychecks before I meet the $15.5K limit. Am I missing something?

  22. It’s because it’s a Self-Employed 401k… I make my own contributions, and they can be both from salary deferrals and as a percentage of my business profits.

  23. I rolled my Roth over to Vanguard just before the market dropped from 14,000. I had to buy new funds within 60 days so I just made a lump sum purchase. It has been painful to look at the statements since then.

    Short term, I think lump sum investing can either be really great or really bad depending on the market’s direction. Long term there probably isn’t a difference with DCA.

  24. DCA can be however you’d like. For example, like you I had 50k to spread into funds back in June during the most recent downturn.. Every day the market went down I bought 10k chunks of FNORX from 45 to 42 till the 50k was done. Now it’s almost at 48. Whether it holds that is debatable but I’m happy to be getting in at a DCA for the 50k over a week of 43.50 or so. If I had bought it in lump sum the week prior it was over 50 and I’d be down instead of up 8% on the investment in less than 3 mos now.

  25. Steve Austin says

    Consider value averaging in lieu of dollar-cost averaging:


    The suggestion of this article is that there is no statistical difference (in returns or risks) between DCA and randomly timing one’s financial transactions. I think DCA is another one of those abused ideas, where the financial industry latches on to it because they are a volume- not performance-based line of business.

  26. Perhaps you could consider Value Cost Averaging. I believe Bernstein touches on it in Four Pillars of Investing. Rather than putting a fixed $1000 each trade, you increase the value of your investments by $1000. So, the first buy is $1000 worth of shares. If the value increases to $1100, then the second buy is only $900. However if the value decreases to $900, then the second buy is $1100. It forces you to buy more when the price is low and less when the price is high.

    Either way, I would probably spread the purchase out over a month’s period at least. Say, $2500 a week.

  27. I think the idea of dollar-cost averaging in is a very good one. I do think however, that you may be doing too much of it if you do $1,000 for 10 days. I would keep it to $2,000 on five days. In this environment your plan makes a lot of sense.

  28. Hey I like that value cost averaging idea. I hadn’t heard about that before!

  29. An older post about Value Averaging

    If you really have the discipline and the desire, it seems like a reasonable thing to do. It think it involves too much monitoring of assets for my personal taste. Some years you may not buy anything at all!

  30. Ted Valentine says

    Jonathan, you’re last statement about the reaction to the announcement is correct. Here’s what’s going to happen tomorrow:

    1. Rate cut 0.25% announced. Stocks run up about 1% to 2%. There will be a sell off the next day by the arbitragers putting the market right back where it was or below Friday’s close.

    2. If the rate cut is more than expected, the same thing will happen, but in greater proportion. The fall might not be as much.

    3. If there is no rate cut the market will lose about 3% this week.

    If I were hedging, I’d bet on a market drop due to this announcement, not a big net increase by the end of the week.

    PS – I have no freakin’ idea what I’m talking about. This is just my guess! 🙂

  31. I don’t understand how your 401K works — I know you said it is a self-employed 401K and your can contribute any amount you like — but where or when do you get the tax break? My money is taken out of my paycheck pre-tax — where do you get your break?

  32. I get the tax break via the paycheck as well for salary deferrals. For the profit-sharing part, I suppose I get it when I file my taxes, I just pay less quarterly estimated taxes throughout the year, and get the official amount when I file taxes.

  33. Hi Jonathan,

    About your self employed 401K…are you actually self employed (make a significant, say >50% of your income from you self employment), or do you base this on a sole propietorship, similar to how one can open a business credit card without actually owning your own business??… how does one set up their own 401K & are there a bunch of fees/costs associated with doing so that i could avoid by just participating in my regular employers 401K…many thanks

  34. lump sum wins again? (or at least for today – buying before the rate cut was good – for now)
    in all reality, if you assume that markets move upward with time, and if you then compare lump sum to DCA, it makes sense that the odds favor lump sum contributions whenever possible…
    glad you went for the lump sum. filter out the noise and stick to your guns

  35. MJK3 – You could earn $1 in profits and be a business, or self-employed. There is no 50% rule that I am aware of. While I could easily be a sole-prop, I decided to incorporate for various reasons. Fidelity’s Solo 401k was the best mix of ease and access to low-cost mutual funds.

    enonymous – Yes, good day, but I bet it’ll drop tomorrow. It’s best to keep things simple, at least for me.

  36. Ha, rate was priced in my hind parts. Even with a lot of people expecting a .5 drop, the market still sky rocketed on the news.

  37. I always thought dollar-cost averaging was better than lump-sum investing, but in a rising stock market, that isn’t true. I wrote a program that used actual historical stock price data looking at some big name stocks like HPQ, INTC, KO, F, etc. I ignored dividends and just looked at stock price. In general, a stock will have a higher price at the end of the year than in the beginning, and in general on any given day of the year, the price will be higher than on Jan 1st. So if you DCA, you will be buying fewer shares over the course of a year, than in you just buy the lump sum on the first day of the year.

    Of course, you could have horrible timing, and buy a stock at the highest point every single year. That is where DCA is supposed to help, to avoid that horrible timing. But in reality it is really supposed to help people who TRY to time the market. If you just buy without looking at the stock price at a fixed time every year, you’ll do better.

    I now invest most of my 401k money in the 1st 9 months of the year, instead of spreading it out over 12 months. (I still need some cash to pay for stuff, otherwise I would do it over 3-6 months).

    I can send you more info if you email me.

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